An intriguing if slightly scary article appeared on Mineweb last week, summarizing a number of earlier interviews and comments by gold market commentators and investment gurus concerning the degree to which gold on deposit in bank vaults actually exists. Or, as the article explains, doesn’t. Confusing? Yes, well, the situation is more than a little confusing, but I will try to explain.
Unlike paper money, which we have always accepted, does not physically sit in bank vaults — following your deposit, it’s instantly recycled into loans and payments by your bank. We have always understood that for those of us fortunate enough to hold physical gold (this author not included), when we deposit our precious bars in a bank’s vault for safekeeping, and the bank starts billing us for storage charges, that gold is sitting safe in their vaults for our eventual return. Secure and instantly available when we want it? Well, maybe not. Anecdotal evidence quoted by Jim Ricards, Snr. MD of Market Intelligence, and James Turk, founder of Gold Money, relayed stories of clients with physical gold and silver in Swiss banks who had to fight for one and two months, respectively, to secure the physical return of their gold and silver holdings. The conclusion in both cases: the banks were no longer holding the physical metal, even though they were continuing to charge the owner for storage.
The article also quotes GATA in saying it has long been known that the amount of gold and silver traded every day on the markets far exceeds the amount actually in existence, and that if everyone demanded simultaneous delivery it would be impossible. That should not come as any surprise; the same ounce can be bought and sold many times in a day representing dozens of ounces when in fact it is the same ounce going around. In addition, many trades are swaps, hedges and other transactions requiring financial delivery, not physical. Nevertheless, the point is probably a fair one that we trade gold and silver as if ever trade was physically backed, with no risk on non-delivery priced in and yet in most cases there is a counter-party risk which like a sub-prime mortgage gets passed around, until one day it doesn’t. As the volume of physical gold taken up by sovereign states like China and by physically backed funds like ETFs has rapidly risen in recent years, it raises doubts about how much metal is actually available for prompt delivery in the market place.
If these stories of bank non-delivery were isolated cases, they could be dismissed as exceptions. But Resourceinvestor ran an article by James Turk providing empirical evidence supporting the view that we have already entered a period of severe and growing physical tightness in gold supply — and he points to the forward price curve to prove it. The London Bullion Market Association (LBMA) forward price curve is normally in contango, meaning the forward gold price is higher than the spot price. The difference is a reflection of the cost of finance and storage of gold for the intervening months. If the spot price is higher than the forward price, the market is said to be in backwardation and is usually the case if spot demand exceeds supply, creating pressure for buyers to pay excessive premiums to secure prompt delivery.
Source: Resource Investor
As these graphs show, both the gold and silver markets have been in backwardation. This degree of backwardation has not been seen since the LBMA databases started in 1989. The fact that 12-month gold is also trending towards backwardation shows the situation is intensifying, says James Turk.
The situation is even worse for silver, where six-month silver has been in backwardation since June 2.
Source: Resource Investor
The likely result, says the committed gold bull Mr. Turk, is rising prices and although we cannot see any justification for a further bull run on gold, we have to agree. One likely solution to a short-term shortage is higher prices forcing more recycling and demand destruction as jewelry and industrial use is hit. Whether that will be enough to counteract rising fund buying, though, remains to be seen. One thing is for sure: it looks like an unpleasant set of opposing forces playing out in the gold market and could be the harbinger of further volatility.